The Russia-Ukraine Conflict: Perspective from NM Investment Leaders

After weeks of speculation and several attempts at a diplomatic solution, Russia has chosen to invade Ukraine.

The incursion has been broadly condemned in the U.S., the European Union and other allied nations, and as we write this, leaders are formulating a response that will likely include the full arsenal of sanctions against Russia.

The day’s events have triggered a wave of volatility across global markets as investors grapple with a rapidly evolving situation. So, what now?

First and foremost, for investors

“This is no time to be making sweeping investment allocation changes,” says Northwestern Mutual Executive Vice President Ron Joelson. “This is a time to sit back and be thankful for the work you and your advisor put into building a diversified, long-term financial plan.” 

The headlines may spark fear, and markets declined based on the news, but a long-term financial plan is built for this. That’s why, in good times and bad, we are always focused on growing and protecting wealth over the long haul. We can’t predict the future with certainty, but we can say with certainty there will be challenges. That’s why we are unflinching in our commitment to broad diversification as the antidote to uncertainty. With a broadly diversified financial plan in place, you’re already prepared for this moment.

When volatility strikes, it becomes clear why various pieces of a financial plan are there in the first place. Northwestern Mutual builds portfolios using a variety of assets that behave differently amid different economic environments. Bonds, commodities, stocks, permanent life insurance, annuities and other assets aren’t to be viewed in a silo; they’re all connected and working together.

“This is exactly why we build for the unknown,” says Northwestern Mutual Chief Investment Officer Brent Schutte. “People see these events and think they should flee and concentrate in cash, but the whole purpose of diversification is to plan for uncertainty so you can stay the course.”

Why are markets shaken?

The invasion appears more severe than perhaps anticipated

Russia’s intentions have hardly been obscure for the past several weeks. Countries don’t regularly send 190,000 military personnel, combat equipment, field hospitals and blood supplies to the border of a neighboring nation for no reason.

However, the scale of Thursday’s military operations appears to be more significant than most expected. Rather than a more gradual push into regions of the country where pro-Russian separatists have a strong presence, Russian forces launched airstrikes on Ukraine’s capital Kyiv and other cities. Russian tanks and armored vehicles were also reported to be seen streaming through border checkpoints. The sheer scale was a surprise.

Markets don’t know what’s next

Markets despise uncertainty, and whenever there’s a sudden shift in policy or geopolitical order, there’s going to be a sharp reaction. The challenge here is no one knows what Russia will do next or what the potential knock-on effects from this conflict may look like. At the outset of events like this, there’s a tendency to catastrophize and play out all the worst-case scenarios under the sun. Fear is always at its highest point when the initial shock sets in, but we can’t forecast what’s coming.

“That uncertainty is why we urge investors not to trade around geopolitical risks,” says Schutte.

Collateral damage from sanctions

The U.S. and its allies have vowed to unleash a full slate of economic sanctions aimed at crippling the Russian economy. Russian stocks have crashed, and the ruble has fallen to a record low. Limiting Russia’s ability to participate in the global financial system and cutting it off from critical industries could undermine President Putin’s support at home and stress its economy. However, those sanctions could also rebound and impact U.S. and European economies.

Europe, for example, imports 40 percent of its natural gas from Russia. Sanctions could lead to higher energy prices if Europe looks elsewhere for supply or Russia decides to cut supply. The market simply doesn’t have clarity on how sanctions will ripple through the global economy yet.

Monetary policy uncertainties

Lastly, markets are also looking to the Federal Reserve. Inflation has been elevated in the United States for several months now, and the Fed was preparing to end its bond purchases and raise interest rates. Will the Russia-Ukraine conflict alter the Fed’s policy schedule? Will the potential for rising energy costs further bolster inflation? Thursday’s invasion has added some fog to Fed forecasts, but we don’t think investors should be overly concerned here.

“If this continues to be a difficult situation, the Fed is going to be easier with policy than people imagine,” says Schutte. “Historically, in moments like this, if demand suffers and consumer confidence wavers, the Fed isn’t going to compound the situation by acting too aggressively.”

Putting the Ukraine conflict into perspective

The worst-case scenario seldom plays out

People often fear the absolute worst outcomes when troubling developments occur. But as history shows, the best- and worst-case scenarios rarely play out as people imagine they will. Rather, reality ends up somewhere in the middle. Markets, too, tend to overshoot optimism and pessimism, but generally settle on a trend line over the long term.

When investors are anticipating the worst, history shows it’s a good time to be optimistic. When surveys of fear in markets, such as investor sentiment or the VIX, reflect an absolute downbeat outlook, returns for investors a year from that time tend to be positive. In other words, it’s absolutely the wrong time to sell when markets are fearful.

“Financial security is not acquired or retained by how you behave when times are good. Anyone can stick to a plan and invest when it’s easy,” says Schutte. “Rather, financial security is acquired or retained by your behavior when times are uncertain.”

Geopolitical risks aren’t new

This isn’t the first time Russia has gone on the offensive and given the global markets pause. In 2008, Russia launched an invasion of Georgia, and in 2014 Russian troops invaded Ukraine and annexed Crimea. After an initial shock, markets settled and adjusted.

“Typically, what happens is there’s a shock in the beginning of these geopolitical conflicts, and then the world moves on and recalibrates to the new environment,” says Schutte.

Even after the attacks on 9/11, the world and markets adjusted rather quickly. Stocks fell 4.92 percent the day of the attack, and markets were closed for days (the first prolonged closure of markets since the Great Depression). But three months later, markets had reversed course and were up 4.05 percent. Markets adapt quickly and are more durable than people tend to think.

Geopolitical risk is a factor, not an investment thesis

Finally, geopolitical risk is just one of many factors to consider when people develop an overall outlook for markets and their finances. Investors also need to consider the state of the economy, their personal goals, interest rates, inflation, taxes and a host of other factors. Geopolitics is an input, but it’s not an investment thesis.

“Historically, when events like we’ve seen in Ukraine occur while the economy is growing, market disruptions tend to be relatively short-lived,” says Joelson.

That doesn’t mean we simply ignore a changing world. A new geopolitical orientation will create headwinds and tailwinds in different countries and asset classes, but we don’t recalibrate portfolios in the fog of uncertainty. The time to rebalance and readjust your risk exposure is in calm markets and on your terms.

Northwestern Mutual is built for this, too

The same principles of diversification and planning that underpin a client’s portfolio also form the financial foundation of Northwestern Mutual. Joelson says the general account, which is a diverse portfolio of investments that allows the company to fulfill its promises to clients, remains incredibly healthy.

“We have a very conservative portfolio, mostly in fixed income. The exposures to Ukraine and Russia are not material to the financial strength of Northwestern Mutual,” says Joelson.

In its 165 years, Northwestern Mutual has endured recessions, depressions, pandemics, world wars and countless geopolitical conflicts. While the times change, our commitment to financial strength, diversification and a conservative approach to risk has not. That same ethos applies to the portfolios we build for clients, so they can feel confident about the future when so many others may be fearful.

“Don’t pull apart your portfolio and judge each asset class individually or on its own merits; rather, think about the risks each piece addresses,” says Schutte. “The future is unknowable, which is why we believe a properly constructed portfolio via a financial plan is necessary to address future risk.”

While risks have risen, they haven’t to a degree that would prompt a change in our outlook. We still believe the economy will push forward in 2022 and eventually pull markets with it. While the Fed will hike rates this year (which could help alleviate inflation), it’s going to proceed with utmost caution to avoid triggering a recession. COVID-19 also appears to be retreating, another positive sign for the economy.

"We think investors who panic out of the market this year will be forced to find a future re-entry point at higher prices as these realities unfold,” says Schutte.

 

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